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The presidents and sole shareholders of several S corporations are employees for employment tax purposes, and the S corporations are not entitled to relief under Section 530 of the Revenue Act of 1978 because such relief is not available for statutory employees. Grey Public Accountant, P.C. v. Commissioner, Nos. 02-4417, 03-2756 and 03-2757 (3d Cir. 04/07/04).

The IRS classified an officer and shareholder of each of three S corporations as employees for purposes of federal employment taxes. The IRS advised them that they were not entitled to relief under Section 530 of the Revenue Act of 1978. As a result, each of the corporate taxpayers was assessed employment taxes for its respective employee under the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA).

Joseph M. Grey Public Accountant, P.C. (JMG) received an IRS notice advising it that the IRS had classified Joseph Grey as JMG's employee. JMG, an S corporation, operated as a public accounting, bookkeeping and tax return preparation business. Joseph was JMG's president and sole shareholder. During the tax years at issue, Joseph solicited the corporation's business, transacted its affairs, handled the financial aspects of the operation and performed all accounting, bookkeeping and tax preparation services. JMG did not make any regular payments to Joseph for the services he rendered during the tax years at issue. Instead, Joseph received money from JMG's bank account as his needs arose. Those payments were reported on Joseph's federal return as non-passive income.

Mike J. Graham Trucking, Inc. (MJG) also received an IRS notice relating to Mike Graham's classification as an employee of MJG. He is MJG's majority shareholder and president. MJG is also an S corporation, operating as a trucking company. Mike solicited business for the company, handled its business transactions, managed its finances and performed the driving services rendered by the company. MJG did not provide Mike with a salary or wages during the tax years in dispute. Rather, Mike distributed money to himself from MJG's bank account as his needs arose, or he paid certain personal expenses which he or his family incurred from the business account. He reported the payments as non-passive income on the K-1 Schedule of his federal return.

Water Pure Systems, Inc. received an IRS notice classifying Martin Ridge as Water Pure's employee for federal employment tax purposes. Water Pure, an S corporation, provided sales and service of water filtration and purification systems. Martin and his wife each owned 50 percent of Water Pure's shares and Martin was Water Pure's president and sole officer. Martin was the only person performing any services for Water Pure. Water Pure did not distribute any dividends to any shareholder during the tax years at issue. Nor did Martin receive regular payments from Water Pure. Instead, he received money from the corporation as his needs arose and those payments were reported as non-passive income on his Schedule K-1 of his federal tax return.

JMG, Water Pure and MJG challenged both the worker classifications and the determination that they were not entitled to relief under Section 530. The Tax Court concluded that the classifications were appropriate and that relief was not available under Section 530's safe harbor provision. They appealed, asking the Third Circuit to disregard the statutory definitions of "employee" and to apply the usual common law rules for determining whether an individual is an employee. Alternatively, they argued that they had a reasonable basis for not treating each worker as an employee and were entitled to relief from the assessment of FICA and FUTA taxes under Section 530.

The Third Circuit affirmed the Tax Court. The court noted that it had recently addressed and rejected, in Nu-Look Design, Inc. v. Commissioner, 356 F.3d 290 (3d Cir. 2004), a similar challenge to the Tax Court's determination that the IRS's classification of a corporate officer and shareholder as an employee was appropriate and that the taxpayer was liable for FICA and FUTA taxes. Since the court was unable to distinguish Grey Public Accountant's appeal from Nu-Look Design, it concluded that Nu-Look Design controlled and affirmed the Tax Court.